The Austrian HETA saga: successful investor appeasement at last?

January 2017 | EXPERT BRIEFING | FINANCE & INVESTMENT

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In October 2016, almost seven years after the emergency nationalisation of the failed Hypo Alpe-Adria-Bank (a €40bn Austrian regional bank based in the province of Carinthia, which in 2014 was re-named ‘HETA Asset Resolution’ (HETA)), the Austrian federal government successfully engineered a liability management exercise that helped rescue Carinthia from the brink of bankruptcy, while accommodating HETA’s disgruntled investors.

From stellar growth and regional market leadership to resolution: a painful journey

Hypo Alpe-Adria-Bank was one of (originally) nine Austrian provincial mortgage banks. Until 2007, it operated under a special statute which made Carinthia, the province that owned the majority of its shares, liable for all of its liabilities. Under a deal agreed in 2003 between Austria and the European Commission, Carinthia’s guarantee expired, however Hypo Alpe-Adria-Bank was allowed to continue to issue guaranteed debt until April 2007, with a term until September 2017. In a growth spell that peaked in 2007, Hypo Alpe-Adria-Bank grew to become Austria’s sixth largest bank. In August of that year, Carinthia sold its shares in Hypo Alpe-Adria-Bank to Bayerische Landesbank.

By that time, the bank had built a large lending network in Central Eastern Europe and South Eastern Europe, with a focus on retail, small and medium enterprise, property and leasing. Initially, Bayerische Landesbank intended to continue this path. However, as the global financial crisis set in, it became apparent that the bank’s business was becoming unsustainable. Hypo Alpe-Adria-Bank was forced to seek a Tier 1 capital injection from the Austrian government in late 2008 and eventually had to be nationalised in December 2009.

In turn, Bayerische Landesbank agreed to extend the term of several billion euros in senior funding that it had granted to the bank by several years. An important motive for the Austrian government’s decision to step in was that, in 2009, Carinthia continued to be liable for more than €20bn of the bank’s debt, against an annual budget of just €2bn. Had the bank gone bankrupt, it would have dragged Carinthia with it.

Following its nationalisation, Hypo Alpe-Adria-Bank continued its operations for several years. In mid-2010, its management proclaimed a successful ‘turnaround’. However, the bank’s losses kept mounting and in 2013, the European Commission required its wind-up. At that stage, the Austrian government still planned to fund the bank and avoid insolvency. Yet, matters continued to deteriorate.

In mid-2014, in the first of a series of steps that profoundly alienated investors, Austria enacted a law that expropriated the bank’s subordinated creditors and – despite the purported senior status of its claims – its former main shareholder, Bayerische Landesbank. The law was swiftly set aside by Austria’s constitutional court. Yet, at the same time, Hypo Alpe-Adria-Bank was stripped of its bank licence and named ‘HETA’. On 1 March 2015 it was put into ‘resolution proceedings’ pursuant to an Austrian law that implemented the European Bank Recovery and Resolution Directive, the EU’s special legislation for failed banks. Just before this, the Austrian government had announced that it was not going to provide HETA with any further funds.

The fact that HETA, no longer a licensed bank, became the first case for proceedings that had been designed to resolve systemically important banks, caused sensation, and not only in legal circles. The market suspected that, as HETA had stopped payments, the resolution process was used to avoid the triggering of Carinthia’s guarantee. HETA was now subject to a ‘moratorium’, a payment freeze declared by the Austrian Financial Market Authority.

At this point, a drama had materialised that involved approximately €12bn in bond creditors – 70 percent of which were German institutional investors, who had been faithful lenders to the Austrian market through many decades and, for their HETA exposure, had relied on Carinthia’s guarantee. A number of them started proceedings against HETA in Frankfurt, as most of HETA’s bonds had been issued under a debt issuance programme that was governed by German law and a Frankfurt choice of jurisdiction clause, hoping that the German courts would refuse to acknowledge the Austrian ‘moratorium’ which they argued had no basis in European law.

For many of them, more was at stake than just their investment in HETA – they feared a precedent of a ‘rich country’ public debtor (Carinthia) being allowed to refuse to honour its liabilities, without actually being insolvent. Carinthia’s liability had acted as an incentive for regulated lenders to subscribe HETA’s debt. A bid made in February 2016 by a government-sponsored fund to purchase HETA’s debt at a price of 75 percent of its nominal amount, which would have helped to shield Carinthia from its liability, was rejected by a large majority of HETA’s creditors.

Unimpressed, on 10 April 2016, the Austrian Financial Market Authority declared a ‘bail-in’ of HETA’s debt, a forced write-down of its senior liabilities to approximately 46 percent and junior liabilities to 0 percent of their original amount. This exposed Carinthia directly under its guarantee – with the bulk of the exposure falling due in 2017 and beyond. Investors started to eye the possibility of suing Carinthia, which had to be done at the courts of Carinthia’s capital, Klagenfurt (with higher instances in Graz and, eventually, the Supreme Court in Vienna).

Finally, a deal negotiated with several consortia formed by large groups of HETA’s lenders, a bid that paid senior lenders 90 percent and junior lenders 45 percent of their exposure, went through in October 2016 with the approval of more than 98 percent of investors. Not unusually for this type of transaction, the deal tilted the odds heavily against holdouts – investors were faced with the alternative of an expected recovery of 50 percent to 60 percent (senior debt) or 0 percent (junior debt) from HETA, and a cap on Carinthia’s liability of just 10.97 percent on the euro. Junior investors (who made up only a few percent of the overall outstanding debt) accepted only grudgingly.

The deal seems to have achieved the seemingly impossible – cramming less than 100 percent recovery down investors’ throats, and saving Carinthia from the prospect of insolvency after years of agony, albeit at a substantial cost to the Austrian federal government (which, formally, was not liable for Carinthia’s exposure and only acted as an ‘intermediary’ between the various stakeholders). Carinthia contributed a mere €1.2bn – much less than the overall cost.

Funding of Austrian public entities: never the same again?

Despite the Austrian government’s generous and skilful intervention, the world of Austrian public finance will not be the same after HETA. For the first time in this well to do part of Europe, investors had to wake up to the new reality of over-indebted public debtors and to a world where longstanding legal certainties can turn into quicksand, as governments try to exploit their double-role as debtors and lawmakers.

Supposedly, an Austrian local authority will find it harder in future to raise funding from trusting institutions, in made-to-order private placements at minimal margins and without having to allow for a lacerating inspection of their finances. The Republic itself may have to take on a bigger role in local funding. Also, Austria contemplates the introduction of an insolvency statute for provinces – which could introduce a sense of reality into matters, but will hardly turn provinces into more attractive borrowers, as the statute will likely limit lenders’ access to the provinces’ assets.